Times of Plenty:

State Responses to Historic Fiscal Conditions

​​Joseph R. CrosbyChairman and CEO
MultiState​Morgan ScarboroDirector, Tax Policy & Economist
MultiState

Introduction

Despite earlier fears that the pandemic would decimate state finances, states are enjoying historic highs in positive revenue. The unexpected windfalls have largely come from federal pandemic aid, online sales tax revenue, and robust stock market returns, according to Joe Crosby, Chairman and CEO, and Morgan Scarboro, Director, Tax Policy & Economist, at MultiState, a state and local government relations consulting company.

​It is critical that legislators make prudent investments, avoiding the temptation to over-appropriate the surplus or create long-term liabilities.

 

This optimistic assessment came with caveats: These days of plenty seem like a luxurious opportunity, but they won’t last forever. As multiple stakeholders clamor to get access to the surplus, it is critical that legislators make prudent investments, avoiding the temptation to over-appropriate the surplus. Senate leaders also need to work with the House and the Executive branch, and will require accurate, up-to-date data on revenue and spending to navigate this time of plenty, the experts advised.

“Storm clouds are on the fiscal horizon,” Mr. Crosby forewarned. Revenue performance and federal aid will eventually return to normal levels. And, while the FY 2022 federal budget allocates $1.4 trillion to state and local governments — an increase of 65% compared to FY 2019 — the U.S. faces growing controversy over its debt level. Additionally, financial markets are starting to make corrections, and Russia’s war in Ukraine adds uncertainty to world finances, adding more unpredictability to the fiscal future.

How is the Surplus Affecting Taxpayers?

Several trends characterize how surpluses are impacting taxpayers, including income and sales tax reductions, tax exemptions, and rebates. No state has imposed a personal tax increase. A number of states reduced the corporate tax rate and 13 states also reduced the individual income tax. Iowa, for example, brought the maximum tax rate down to 3.9%. Tax triggers are being implemented by some states. The corporate tax rate is set to decrease by .5% per year in some states; while in others, tax reductions are linked to revenue benchmarks. Rebates are being enacted by a few states and, in others, temporary reductions or exemptions from sales taxes have been passed.

 

​States Have Record Levels of Revenue

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Courtesy MultiState

Prudent Allocation of the Surplus

Rainy Day Funds

Shoring up Rainy Day Funds is a key priority, Ms. Scarboro pointed out, and the pandemic served as a powerful reminder of how important it is for states to plan for uncertainty. These budget stabilization funds may be used to supplement general fund spending during an economic downturn or other event triggering a shortfall — such as was threatened by the pandemic — when specific restrictions are met.

Despite fears to the contrary, state revenue collections in fiscal 2021 exceeded budget forecasts in nearly all states — at times by a substantial margin — and investments in Rainy Day Fund levels rose to historic levels in most states. Many states also increased the minimum size required and/or maximum size limit for their Rainy Day Fund balance to increase the margin of safety in uncertain times.

State unemployment insurance coffers have been depleted during the pandemic and the federal loans to shore up these funds must be repaid. Allocating surpluses to repay loans and stabilize unemployment funds is prudent, Ms. Scarboro noted.

For states that have used federal funds to extend weeks of unemployment benefits, for example, April 1st looms as a critical deadline. Federal funds must be used before that date or states will face a “maintenance of effort” requirement that will keep the extended benefits in place through 2026.

​For states that have used federal funds to extend weeks of unemployment benefits, April 1st looms as a critical deadline.

Morgan Scarboro, Manager of Tax Policy & Economist at MultiState, compared state revenues during the first three quarters of FY 2020 and FY 2021. She noted an overall increase in state tax revenue of 12.1%, without considering federal aid. While eight states saw some loss of revenue, only three (Alaska, North Dakota, and Hawaii) had losses greater than 3.5% (see map).

Rainy Day Funds

Most states need to catch up with contributions to their pension funds, Ms. Scarboro noted. With equities showing 30% growth last year, states have the opportunity to invest the excess to shore up their pension funds. New Jersey, for example, met its full contribution to its pension fund for the first time in many years.

American Rescue Plan Act (ARPA) funds are restricted to replace lost public sector revenue, provide premium pay for essential workers, and invest in water, sewer, and broadband infrastructure but they cannot be used for pension funds; therefore, it’s prudent to allocate existing excess state revenue to these plans.

 

​What are States Doing with the Surplus?

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Courtesy MultiState

 

Discussion

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Moderated by

Tom Finneran

Tom Finneran opened the discussion, noting that, in times of plenty, competing interests within the state clamor for a share of the available funds. Given stakeholder pressures on members of the House, Senate and the Executive branch, such allocations can pose a political dilemma. Mr. Finneran queried, “How is the excess state revenue being allocated in your state? Who is driving these allocations?”

Sen. Ron Kouchi
President of the Senate, Hawaii

The state’s pandemic response was driven by the Governor and the Health Department, and their forced closures decimated our economy. The Governor’s Emergency Proclamation ends March 25th, and the legislature is looking at ways to curtail the Governor’s ability to declare emergency powers in the future. Having faced this, our legislature recognizes the risks and opportunities of the windfall. We have a $350 million Rainy Day Fund, but legislators say, “It’s raining now.” We are looking to restore activities that were cut in the downturn. Visitors are now returning to Hawaii but, on average, they are spending 20% less than pre-pandemic levels.

Meanwhile, the opportunity to work remotely brought many higher-echelon workers to the state who can afford to buy million-dollar homes, raising prices and outpacing the ability of local workers such as teachers — who earn a median salary of $100,000 — to find housing. Workforce housing is a critical need and the legislature is assessing a $1 billion investment in affordable housing. We anticipate that the construction projects will not only help to retain our workforce but also produce economic benefits for the community.

​The legislature is assessing a $1 billion investment in affordable housing. We anticipate that the construction projects will not only help to retain our workforce but also produce economic benefits for the community.—Sen. Ron Kouchi (HI)

Sen. Bray said he is “cautiously optimistic,” because the future is uncertain; for example, inflation could be a coming threat. Therefore, while some legislators have reacted to the excess by proposing permanent tax cuts, he advises continued caution in making changes.

Sen. Karen Fann
President of the Senate, Arizona

The state’s economy is booming. Online sales tax revenues are way up thanks to the Wayfair decision, and the housing market is hot with new construction everywhere, bringing in substantial sales taxes from construction. The state has attracted significant new industries such as the Taiwan Superconductor Plant.

While Arizona’s economy looks great, Sen. Fann expressed concerns about the national debt climbing to $30 trillion, as federal funds continue to pour into the states. She suggested the need to put brakes on federal spending because of the burden of debt on future generations.

Furthermore, lack of labor force is a challenge. While the state stopped taking Federal Supplemental Unemployment Insurance benefits last year, “COVID folks aren’t going back to work yet,” she said. Sen. Fann further alluded to the housing issue facing all states, pointing out that the homeless in Arizona need shelter from the heat plus services such as those addressing mental health.

Sen. Fann also noted that water is always a huge issue in Arizona. The state is setting aside $1 billion for water resources. Most water is used for agricultural purposes, and, taking lessons from Israel, the state is converting flood irrigation systems to drip irrigation, which is expected to reduce water usage by 25%.

Sen. Bill Ferguson
President of the Senate, Maryland

Sen. Ferguson reported that Maryland has $500 million extra in the current fiscal year’s budget, the biggest surplus during his 12-year tenure in the legislature. The unexpected windfall brings the challenge of more people asking for more money. Where they formerly requested $1 million, now they ask for $150 million. We are all up for election and have to resist the pressure to do the wrong things for short-term gain that could have long-term negative consequences.

We have allocated surplus money to our Rainy Day Fund and are looking at investments in workforce development. Retirements are a huge issue in Maryland, particularly for state employees. We're losing significant institutional knowledge across state government. We need to invest to retain state employees, and keep local workers such as healthcare workers, attorneys, and others in our state. We have a “skill and build” program — an apprenticeship program in the building trades. Now we are developing an apprentice program in non-building trades to upskill people so they have increased access to economic opportunities.

​“Retirements are a huge issue in Maryland, particularly for state employees. We're losing significant institutional knowledge across state government.”—Sen. Bill Ferguson (MD)

Mental health is another area of focus and concern. The system is broken and we are exploring ways to enhance access, especially for children, many of whom have been deeply affected by the pandemic.

Finally, in response to a query from moderator Tom Finneran on “Who is driving allocations of the surplus,” Sen. Ferguson reported that, despite a party split between the Legislature and the Executive branch, a great working relationship is maintained and compromises are negotiated.

Sen. Thomas Alexander
President of the Senate, South Carolina

The Legislature is driving the decisions in South Carolina. We are a legislative state and plan to keep it that way. Our state surplus is enabling transformative opportunities. We are investing for the future, not “spending.”

For example, a proposed income tax cut is currently being reviewed in the Senate in a bid to keep us competitive with adjacent states. We’ve allocated ARPA funds with $900 million going to water and sewer projects, with a 25% match from localities. Another $400 million, with matching funds from internet service providers, is devoted to achieving 95% broadband coverage for the state.

Mental health needs are being addressed with a $200 million investment, and $100 million is being invested to develop a new health laboratory. Like in other states, housing is an issue as property prices have skyrocketed beyond the average worker’s reach. There is no inventory of available homes at accessible price points; therefore, workforce housing is a major need.

​Our state surplus is enabling transformative opportunities. We are investing for the future, not “spending.”—Sen. Thomas Alexander (SC)

Sen. Larry Taylor
Chair, Senate Education Committee, Texas

Because the Texas Legislature only meets every other year, control over allocation of the surplus was in the Legislature’s hands during the session, and special sessions kept us meeting through October. The Governor has control when the Legislature is not in session, but the Legislative Budget Board works closely with the Governor.

The Legislature allocated some of the surplus to beef up the pension fund, and unemployment insurance fund deficits were paid off without putting an additional unemployment tax burden on companies.

Education is a key focus, with $16 billion in federal dollars being allocated to schools and tutoring projects to help children make up pandemic-related deficits. Technology enhances education; every child now has a computer, and broadband access is available in 98% of schools and is being expanded to rural areas. Extra money was assigned to education including a 13th-month extra check for teachers.

​Technology enhances education; every child now has a computer, and broadband access is available in 98% of schools and is being expanded to rural areas.—Sen. Larry Taylor (TX)

Sen. David Sokola
Senate President Pro Tempore, Delaware

Addressing the question, “Who is allocating the surplus?” Sen. Sokola quipped that “there are 20 hands on the steering wheel.” It is a significant discussion because some investments can add to the base, and you have to keep funding them. Therefore, the Legislature has made clear-cut, one-time infrastructure investments in water, housing and broadband. The state has its healthiest budget reserve and has allocated surplus money toward enriching the unemployment benefits fund and the state’s pension fund.

Like other states, Delaware sees a challenge in workforce recruitment. Many people are retiring early, even before age 65, both in the public and private sectors. Teachers, for example, have full medical benefits after 30 years and do not have to wait for Medicare coverage at age 65. Additionally, across the border in Maryland, an ambitious education funding plan starts teachers at a salary of $60,000 with the promise of rapid pay increases. This ups the ante for adjacent states who want to retain their education workforce.

 

​Common state targets for revenue surplus• Workforce housing• Education• Mental health• Workforce development

The Road Ahead

Wrapping up the session, Mr. Crosby assessed the near fiscal future, noting that there are positive indicators such as increasing real estate values, growing employment, and better labor force participation, although he acknowledged that participation is still not at pre-pandemic levels. Inflation also could be a positive force in the short term, driving up wages, prices, and sales tax revenues.

However, he predicted that by the end of Q3/Q4 2023, the revenue bonanzas are likely to diminish. Current supply chain breakdowns are leading to a lack of products, especially consumer items such as cars and technology essentials such as computer chips, which that will impact sales tax revenues.

​By the end of Q3/4 2023, the states’ revenue bonanza is likely to diminish, reinforcing the urgency for fiscal prudence.—Joe Crosby, Multistate

Mr. Crosby outlined the concerns that could derail the states’ booming economies, factors that, among others, reinforce the need for states to focus on fiscal prudence:

· With stakeholders clamoring to benefit from the current surplus, prudent investing is critical.

· As federal aid to the states recedes toward more traditional levels, underlying and unresolved issues will be revealed.

· Asset prices will moderate, no longer delivering 30% increases.

· Inflation can be a two-edged sword; will the Federal reserve get it right?

 

Speaker Biography

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Joseph R. Crosby

Chairman and CEO
MultiState

Joe Crosby is the Chairman and CEO of MultiState, a state and local government relations company. He is involved in all aspects of the firm’s efforts to help clients resolve the challenges they face in the state and local government arena, with a concentration on providing strategic counsel, identifying and deploying political assets, and advancing tax policy objectives.

Joe Crosby’s full bio

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Morgan Scarboro

Director, Tax Policy & Economist
MultiState

Morgan Scarboro joined MultiState in 2018 and currently serves as Manager, Tax Policy and Economist. She uses her expertise in state tax policy to advise clients on policy trends, manage state advocacy coalitions, and track corporate income tax legislation across the country. She is a frequent panelist for state tax policy events and updates. Morgan also serves as co-chair of the Women in Government Relations' State Relations Task Force.

Morgan Scarboro’s full bio